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Consider the accounting, tax and deals implications when planning common control transactions
Observations from the front lines
Highlights
- Spurred by Brexit, tax reform, and other regulatory changes, many entities are considering organizational changes to prepare for—or respond to—shifting market dynamics.
- Restructuring within a common control group can create tax and accounting complexities and require multiple judgments.
- Appreciating the potential complexities will help companies understand impacts to financial reporting.
Why it matters
A common control transaction is a transfer of assets or an exchange of equity interests among entities under the same parent’s control. “Control” can be established through a majority voting interest, as well as variable interests and contractual arrangements. Entities that are consolidated by the same parent—or that would be consolidated, if consolidated financial statements were required to be prepared by the parent or controlling party—are considered to be under common control. Determining whether common control exists requires judgment and could have broad implications for financial reporting, deals and tax.
Some examples of common control transactions
Common control transactions arise in a range of circumstances. If your organization is contemplating any of the following, we recommend an early assessment of the implications:
- A reporting entity charters a newly formed entity to effect a transaction.
- A UK-domiciled company transfers assets to a subsidiary domiciled in a different jurisdiction.
- Two companies under common control combine to form an LLC.
- Prior to spin-off of a subsidiary by a parent entity, another wholly owned subsidiary transfers net assets to the “SpinCo.”
- As part of a reorganization, a parent entity merges with and into a wholly owned subsidiary.
Common control transactions fall outside the scope of the guidance for business combinations (ASC 805) because there is no change in control over the assets by the ultimate parent. This means that assets transferred to the entity are generally not stepped up to fair value. Instead, they are recorded at the ultimate parent’s historical cost basis. Exceptions to this general rule include the transfer of financial assets between entities under common control (ASC 860) or recurring transactions (intercompany sales/transfers of inventory). For more information on these exceptions please refer to our Business Combination Guide.
Whether the transaction should be retrospectively or prospectively applied is dependent on the nature of the common control transaction. Transfer of net assets or a business are reflected retrospectively, whereas transfers of assets are prospective. Judgment may be required around the following areas:
1. Is the transaction a transfer of an asset or of a business?
- If the transaction qualifies as a business, reporting changes are necessary at the subsidiary level.
- The new definition of a business (ASU 2017-01) generally classifies fewer transactions as businesses. However, it still requires judgment to assess whether there was a transfer of a business or an asset.
- When the transaction involves a process and/or workforce—as is the case in many common control transactions that realign departments or entities—classification as a business is generally appropriate.
2. Has there been a change in the reporting entity?
- ASC 250-10, Accounting Changes and Error Corrections, provides guidance on accounting for a change in the reporting entity in three circumstances:
- Presenting consolidated or combined in place of individual entity financial statements.
- Changing specific subsidiaries.
- Changing the entities included in combined financials.
Due to the limited guidance, judgment is required to determine whether the receiving entity has undergone a change in the reporting entity.
- Prospective application is available for a transfer of an asset (or assets) where there is no change in the reporting entity.
- Retrospective application is required for the transfer of a business. This entails a change in the reporting entity, which may create complexities around cumulative translation adjustments as well as segment, goodwill and reporting unit assessment considerations.
Deals impact
It’s important to remember that seemingly straightforward transactions can introduce common control complexities. For example, the receiving entity should account for the transaction at the ultimate parent’s historical basis. However, this does not always mean “carrying value” as there are often instances where the parent’s basis is not pushed down to the subsidiary.
Planning
Capital structure, valuation, and divestiture and disposals should be carefully considered during the planning stages, which can include:
- Developing a clear roadmap of the economic objectives driving the transaction to align goals internally and with advisors.
- Determining the appropriate commercial, legal, tax, financial reporting, valuation, and regulatory skills needed to complete the transaction.
- Considering the post-acquisition financial reporting implications, including how the transaction will be communicated to stakeholders and impacts to existing debt covenants or other agreements.
Tax impact
Common control transactions can also create significant tax implications. Organizations will benefit from thinking through issues around combined basis and consolidated tax returns, including:
- Whether an operating loss carryforward can be applied, and
- the corresponding establishment of a deferred tax asset and valuation allowance.
In a common control transaction, the tax basis of net assets acquired will result in temporary differences that impact the recognition of tax benefits.
Summary
As businesses navigate shifting market dynamics, an up-front and in-depth analysis of potential transactions can help avoid unintended consequences. This analysis is particularly important due to the recent updates to the FASB’s new definition of a business. PwC can help with this assessment early-on and can provide expertise and guidance throughout the process—from initial planning to post-acquisition financial reporting implications.
For more in-depth accounting guidance on these and other issues, visit us at pwc.com/us/cfodirect.
“Observations from the front lines” provides PwC’s insight on current economic issues, our perspective regarding the financial reporting complexities, and what companies should be thinking about to effectively address those issues. For more information, visit www.pwc.com/us/cmaas.
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